As the 10th anniversary of the last financial crisis quickly approaches, it is an opportune time to think through how to protect your company from the next financial crisis. Make no mistake -- while the economy at the moment is strong, it is inevitable that another major crisis will happen in our lifetimes.
In fact, it is precisely moments of prosperity like this one that precipitate the false hubris that leaves companies woefully unprepared for economic downturns. So how can entrepreneurs avoid being totally unprepared when the next financial crisis happens, and where are the current vulnerabilities in the market? Here are a few tips.
1. Increase your company's awareness of how a financial crisis happens and how your company is exposed
While financial crises are on the one hand perfects storms -- a confluence of bad policy, ineffective regulation and human behavior, all of the financial crises over the past 30 years follow the same pattern of events. So even if the precise timing of when a crisis will "hit" is impossible to predict, we can understand where the economy is in the cycle of events that form crisis to prepare.
Every crisis follows the same path: the deregulation of a market leads to some type of widespread credit expansion, particularly to risky borrowers. Then, a trigger occurs; for instance, a market self-correcting (such the sudden drop in the U.S. housing market during the last crisis, or the sudden depreciation of the Thai Baht during the Asian financial crisis).
This leaves a large portion of a market unable to finance their debt, which creates a widespread default and a drop in general in the confidence of the health of the economy. A decline in lending follows, which then amplifies the crisis, as companies dependent on outside financing are unable to make payroll and invest.
Given that this is the general formula for the pattern of events that lead to crisis, it is important to understand which specific markets are currently vulnerable and the extent of your company's exposure to this vulnerability in order to prepare for the future.
2. Slowly expand your corporate debt
Currently, the global corporate debt market is the market to watch in terms of future fragility. There has been both a widespread expansion and increased risk in corporate lending and bond issuance since the last crisis. Furthermore, as a result of this market ballooning, a record amount of bonds will mature between 2018 and 2022. And with interest rates rising, this will not only create a harder environment for refinancing, but could trigger a crash in the bond market as the price of bonds fall.
In this environment, companies where debt expands faster become increasingly risky in relation to those with the slowest debt expansions. So to prepare your company for the potential riskiness of growing debt, entrepreneurs should increase borrowing slowly, if taking on new debt at all is necessary.
3. Hedge exposure to China
Ballooning corporate debt is an even more concerning problem in China, as it is concentrated in even riskier companies. By some accounts, China's share of corporate bond at risk of default could soon rise to 43 percent. Compounded with the recent geopolitical friction with China in terms of trade, entrepreneurs should be particularly careful in understanding their business' exposure to China. Relying exclusively on China for key relationships could prove risky in the coming years.
In particular, if your customer base or supplier relationship relies on a healthy Chinese economy or open trade, this could severely impact future growth in an increasingly vulnerable Chinese economy. To prepare for this, entrepreneurs should map out options to diversify their relationship to the Chinese economy. For instance, for those using Chinese suppliers only, sourcing options in other countries for manufacturing should be explored.
4. Work through crisis scenario models
While it may seem alarmist, spending time to analyze the vulnerabilities of your business to the economic environment is an important step in protecting your company from future downturns. The business plan in its entirety should be dissected for crisis scenario vulnerabilities. This is best done with help from the outside, as entrepreneurs entrenched in their own company will have a hard time poking holes at their own exposure.
Difficult questions (need to be asked and answered, such as "if our target market no longer has money to spend on our product, what will we do and how long can we last?", or "if our next line of credit Is no longer available, how will we fund purchase orders?" While these questions and this exercise in general may seem apocalyptic in nature, this is close to what many entrepreneurs experienced in 2008. Without a plan for what would happen during crisis, founders are steering the ship into potentially rough waters with no map.
While the economy currently is strong, another financial crisis will inevitably rear its ugly head. And the most proactive step an entrepreneur can take is to become aware and preparing, instead of burying their head in the sand about the fact that this will happen again.